A penalty clause in an employment contract is no child's play

A penalty clause in an employment contract is only valid if it is recorded in writing, specifies exactly which regulations the penalty applies to, states the penalty amount, and determines where the payment is made. Furthermore, strict protective rules under labor law apply to so-called disciplinary fines (violations committed during employment). If you do not comply with these, the clause will quickly become invalid, or the court may reduce the penalty. Therefore, draft a penalty clause carefully; otherwise, as an employer, you offer a false sense of security.

An employment contract often contains numerous clauses, such as confidentiality, non-competition, or non-solicitation clauses. To reinforce these agreements, an employer sometimes attaches a penalty clause: whoever fails to comply pays. However, as an employer, you had better pay close attention, because such a penalty is not automatically enforceable. Below, we at MKB Juristen explain when a penalty clause holds up and when it does not.

What is a penalty clause?

A penalty clause (also known as a contractual penalty) is a clause in which two parties agree that one party must pay a predetermined amount to the other party if it fails to comply with an agreement in the contract. You will find penalty clauses in many types of contracts, and therefore also in employment contracts.

In an employment contract, a penalty clause usually has two functions:

• Enforcing compliance. The fine acts as an incentive to take regulations and stipulations seriously.
• Compensating for damages. The fine can serve as compensation for (potential) damage caused by the violation.

The basic principle of the Civil Code is that an imposed contractual penalty takes the place of compensation for damages for the same violation. Therefore, in principle, you cannot claim both the penalty and the actual damages suffered. An important exception applies to this point in the case of employment contracts, which we will discuss further below.

Is a penalty clause in an employment contract valid?

In principle, including a contractual penalty in an employment contract is permitted. However, it is important to record the clause in writing and formulate it clearly. It must be clear what the penalty applies to, how much it is, when the employee owes it, and to whom the amount is due. The purpose of the penalty must be explicitly stated in the clause.

A penalty clause is therefore not a matter of “freedom and flexibility”. The Civil Code establishes both general rules (for all penalty clauses) and specific rules (specific to employment contracts). We explain these below.

General rules for penalty clauses

The general rules regarding penalty clauses are set out in Articles 6:91 to 6:94 of the Dutch Civil Code and apply to all penalty clauses, including those in an employment contract. The key points:

• Choosing between performance or a penalty. The creditor must choose: he demands either performance of the violated obligation or payment of the penalty. For example, if the employment contract stipulates that an employee returns the mailbox keys at the start of their vacation, the employer cannot simultaneously demand the return of the keys and the penalty in the event of non-compliance.
• Fine instead of compensation. If the party opts for the fine, it cannot, in principle, also claim the actual damage suffered.
• Notice of default and imputability. The penalty can usually only be imposed after the counterparty has been given notice of default, and only if the violation is attributable to it. In the case of force majeure (such as an employee hospitalized), there is no attributable failure to perform.
• Power of the judge to mitigate. The judge may reduce an excessive fine.

Deviation is permitted (partially). You may deviate from a number of these general rules in the employment contract, provided this is explicitly stated in the penalty clause. For example, you can stipulate that a prior notice of default is not required. However, you cannot exclude the judge's power to mitigate.

Special rules for the penalty clause in an employment contract

In addition to the general rules, supplementary protective rules from Articles 7:650 and 7:651 of the Dutch Civil Code apply to disciplinary fines in an employment contract. These protect the employee and are partly mandatory. The most important formal requirements:

• The clause states which regulations are subject to the fine.
• The amount of the fine has been specifically determined.
• The destination of the fine is included.
• The clause has in writing .

If one of these formal requirements is not met, the penalty clause is in principle invalid.

In addition, substantive rules apply :

• No enrichment of the employer. The fine may not (directly or indirectly) benefit the employer or the person authorized to impose the fine. In practice, the proceeds are therefore often earmarked for, for example, a charity or an employee fund.
• Same currency as the salary. The fine must be expressed in the same currency as the salary is paid.
• Limitation of the amount. The law limits the total amount of fines that can be imposed per week. For employees earning no more than the statutory minimum wage, a number of these substantive rules cannot be deviated from to their detriment. If the employee earns more than the minimum wage, it is possible to deviate from specific provisions in writing.

A breach of the substantive rules does not automatically lead to nullity, but the judge may reduce the fine. Therefore, have the exact wording and amount checked; the precise limits are a technical matter that many employers struggle with.

Note the right of choice regarding employment contracts. In ordinary contracts, the penalty generally takes the place of compensation for damages, unless otherwise agreed. In an employment contract, the starting point is the other way around: the employer has a right of choice between compensation for damages and a penalty (Article 7:651 of the Dutch Civil Code). However, claiming both simultaneously for the same violation is not permitted.

No special rules regarding the breach of a non-compete or non-solicitation clause

The special rules in Articles 7:650 and 7:651 of the Dutch Civil Code apply primarily to disciplinary fines: fines for violating rules of order and conduct during employment. The Supreme Court has ruled that penalty clauses linked to a non-competition clause or non-solicitation clause do not need to comply with these special rules. This also applies to fines for obligations that only arise after the termination of the employment contract. The general rules in Book 6 of the Dutch Civil Code (such as the judge's power to mitigate) naturally remain applicable.

What are the risks of a defective penalty clause?

A penalty clause that does not meet the requirements often backfires. The most important consequences at a glance:

• Invalidity. If the clause lacks a formal requirement, such as written recording, a specific amount, or the purpose, you cannot, in principle, invoke it as an employer. The penalty is then a dead letter.
• Mitigation by the judge. If the clause is valid but the penalty is disproportionate to the violation, the judge can substantially reduce the amount. A high amount on paper therefore offers no guarantee.
• Reputation and employment relations. A fine that fails legally or appears excessive can unnecessarily strain the relationship with your employee.

Are you facing a conflict regarding a fine or another employment law dispute? Our legal experts offer targeted legal assistance and assess the chances of success with you.

Practical example: when does it go wrong?

An employer includes the following in the contract: “In the event of a violation of the house rules, a fine of 500 euros per violation is due.” This sounds clear, but this clause carries risks on several points. Which house rules exactly? To whom is the fine payable? Is the amount in line with the statutory weekly limit? If this information is missing, the fine may be invalid or reduced by the court, precisely at the moment you need it. A good penalty clause is therefore specific, in writing, and drafted correctly in substance.

Practical tips for employers

• For each violation, specify exactly which regulation is being violated and assign a fixed amount to it.
• Specify the destination of the fine and ensure that it does not end up with you as the employer (in the case of disciplinary fines).
• Distinguish between disciplinary fines (during employment) and fines under a non-compete or non-solicitation clause (after termination). The rules differ.
• Keep in mind that the judge can always reduce; set the amount realistically in relation to the offense.
• Have your employment contract and penalty clauses legally reviewed.

Frequently asked questions about the penalty clause

Is an employer allowed to keep the fine themselves?

This is not the case with disciplinary fines. The law stipulates that the fine may not (directly or indirectly) benefit the employer or the party authorized to impose fines. Therefore, the destination is often specified as, for example, an employee fund or a charitable cause. The situation is different for fines related to a non-compete or non-solicitation clause.

Can the judge mitigate a penalty clause?

Yes. The judge has the power to mitigate and can reduce an excessive fine. You cannot exclude this power in the employment contract. Therefore, an unrealistically high fine offers no guarantee that you will receive the full amount.

Is a verbally agreed fine valid?

No. A penalty clause must be recorded in writing. An oral agreement does not meet the requirements and is therefore, in principle, unenforceable.

Are you allowed to claim both a fine and compensation for the same offense?

No. The employer must choose between the contractual penalty and compensation for the actual damage suffered. It is not possible to claim both for the same violation, unless the clause expressly provides otherwise within statutory limits.

Does the penalty clause also apply in the event of a breach of a non-compete clause?

A penalty imposed under a non-compete or non-solicitation clause is permitted, but is not required to comply with the special rules of Articles 7:650 and 7:651 of the Dutch Civil Code. However, the general rules (including the judge's power to mitigate) do apply. Careful wording therefore remains important.

What happens if the penalty clause does not meet the requirements?

If it does not meet the formal requirements (such as being in writing, specifying a concrete amount, and the intended use), the clause is in principle invalid. In the event of a violation of the substantive rules, the clause remains valid, but the court may reduce the penalty.

Have a penalty clause drafted or reviewed?

A well-drafted penalty clause prevents unpleasant surprises later on. Our legal experts will draft it for you, review your existing employment contract, and advise on the correct wording and amount. View our expertise in employment law or choose a suitable employment contract. Would you prefer to brainstorm with a legal expert? Schedule a no-obligation intake and we will think along with you.